Thanks, Terry, and good morning, everybody. I'm going to talk more about PPP this quarter.
I think it's important, so you can better understand how we believe our second quarter results were impacted.
Excluding PPP from our EOP balances results in a $99 million reduction in our loans for the quarter.
As Terry mentioned, last quarter, we had about $250 million in commercial line draw increases.
This quarter, line draws were down by $380 million. Line draws were at 50.7%, which is the lowest I can remember in recent memory. Loans are coming in at a slower pace, but there are opportunities. We still believe based on discussions with our market leaders and commercial lenders that annualized loan growth will land in the low to mid-single digits for this year, of course, after excluding the impact of PPP.
As to looking forward, we're not anticipating any reduction in PPP loan balances in the third quarter. That may be conservative, but we don't have good forgiveness rules yet.
So that's the decision we've made for the third quarter. The SBA told Congress that they hope to have their forgiveness portal up and running by August, we'll just have to see. Average balances for PPP loans was $1.7 billion in the second quarter.
Our third quarter forecast for average PPP loans is slightly more than $2.2 billion.
Our yield on PPP loans was 2.89% in the second quarter.
So the third quarter should be fairly consistent based on our note paydown assumptions. We're forecasting principal reductions in PPP loans in the fourth quarter.
Our internal forecast anticipate that 13% of our $72 million in PPP fees will amortize into income in the third quarter and then 37% in the fourth quarter, given our guests that we will likely get meaningful PPP forgiveness in the fourth quarter.
Now to deposits.
As Terry mentioned, there was a huge deposit quarter for us. End-of-period deposits were up almost 26%, while core deposits are up 15% over March 31. Significant growth in noninterest-bearing deposits ending at $6.9 billion. There's a chart in the supplemental information that characterizes the second quarter growth for loans and deposits. We're estimating that the PPP program provided about $1.7 billion of our deposit growth for the quarter. This is a rough estimate because it's practically impossible to determine a precise number. That number is simply the net growth in PPP borrower’s deposits between March 31 and June 30. We do anticipate that a meaningful amount of these deposits will move off our balance sheet over the next few quarters as the PPP borrowers use those funds. The rest of the same quarter growth was split $1 billion in client growth and $1.4 billion in wholesale deposits. Wholesale deposits were acquired as part of our decision to amp up our liquidity as a result of COVID. In all likelihood, we'll see some of these wholesale deposits decrease in the third and fourth quarters, so we intend to let our liquidity return to more traditional levels over the next 12 months. This is all contingent on COVID and obviously progress toward the vaccine.
Next is the usual update to our loan pricing.
Given the circumstances, very pleased with how loan spreads have held up when you consider the 30-day LIBOR average about 1.4% in the first quarter. That fell to 35 basis points in the second quarter and will likely be 15 to 20 basis points in the third quarter.
Our relationship managers are working with borrowers to increase LIBOR spreads and are finding success.
As noted on the slide, our second quarter LIBOR rates for new loans were at 3.15% compared to 2.85% of the entire LIBOR portfolio. Prime-based credit is hanging tough, basically trying to keep a fore handle on these credits, getting more and more successful in achieving loan floors on the prime and LIBOR book.
So we are excited to see that occurring, more on that in a minute. Fixed rate lending is also hanging tough we're giving up some yield on new fixed rate loans as new loans come in at around 4% in the second quarter with a total fixed rate book yield of around 4.35%.
Forecasting loan yields in this environment is pretty difficult right now, given the uncertainty around PPP loans. We should experience some loan yield contraction in the third quarter, given the impact of PPP and where LIBOR is covered. Offsetting these two items for us will be the success we're having in loan floors. At June 30, we had $2.7 billion in shorter-term variable rate credit with a loan floor, and that number is up from $2.1 billion at March 31.
We also have $800 million in shorter-term variable rate credit that comes up for renewal between now and year-end 2020 that doesn't have a loan floor yet.
One of the big opportunities we have as we work our way through 2020 is to build loan floors into our prime and LIBOR loan books, doing that will obviously help us as we ramp into 2021 in this lower for longer flatter yield curve. I'm not going to spend a great deal of time discussing deposit pricing. This is obviously not a new chart, and it seems like deposit betas or so last year. That said, the other big thing we can do as we focus on building our ramp into 2021 is managing our deposit and total funding cost. We see no reason we should not be targeting a range of less than 25 to 30 basis points for deposit costs by year-end.
Our relationship managers have their client list and are working with them aimed at depositors who have higher deposit pricing.
We have approximately $1 billion in CD renewals in the second half of the year, and we will be gradually reducing our wholesale funding balances, both of which will serve to reduce funding costs.
Now we're bringing this information forward from last quarter, I'm not going to spend a lot of time this quarter as much of the information we've already covered. The NIM chart on the top left goes back to 2007 and tracks our NIM in relation to Fed funds target rates. We all know we've operated in a zero rate environment before.
So here we go again. Hopefully, it won't last for seven years like it did last time. Obviously, loan floors are critical in this environment, so we are pleased with where we are with the information on the bottom left chart.
As we mentioned in our press release last night, we believe that both PPP and our excess liquidity negatively impacted our NIM by 32 basis points. There's a slide in the supplemental information that shows how we calculated a number, but suffice to say that these two events have impacted our reported net interest margin meaningfully.
Looking to the third quarter, we're optimistic that the GAAP margin will hold fairly steady and be somewhat dependent on our third quarter PPP results.
We will obviously have to counterpunch the reduction in LIBOR with a build-in loan floors and reduce deposit pricing. Average liquidity, hopefully, will be down by a modest amount in the third quarter so that, too, should be helpful.
Now to fee income. I'll be really brief. These were more than $72 million for the quarter, up slightly over last quarter and the same quarter last year. Taking BHG out of the calculation reflects significant growth as mortgage carried today during the second quarter. Consistent with other financial institutions, it's been a huge refinance quarter, and their pipelines are really strong currently, but we are anticipating a repeat of Q2 but we've underestimated the results from this group before. Wealth management revenues were down this quarter from last quarter, primarily based on advisory fees for investment services where fee revenues are received in arrears and are based on market performance. We should see these revenues come back in the third quarter with a broader market rebound that has occurred. BHG contributed approximately $17.2 million, which was slightly more than we anticipated, but more on BHG in a second.
So now briefly on expenses. Personnel costs were down $7 million from the prior quarter due to reduced incentives and reduced benefit costs. We don't have an exact number for PPP overtime cost, but over time is up about $300,000 this quarter over last quarter.
As the benefit caused several speculate that medical expenses are down due to elected procedures being sidelined for some portion of the quarter, maybe so. Consistent with prior years, the usual reduction in payroll and unemployment taxes also contributed to the reduced benefit cost.
As to COVID-related savings, we anticipate around $30 million to $40 million in incentive savings for both cash and equity incentives as earnings are not being achieved for this year. We probably have another $3 million to $5 million in savings from travel, entertainment, expense reimbursement and other things that I really haven't thought about.
Our cash incentive accrual was at 25% at quarter end. This resulted in $4 million to $5 million reduction in incentive costs this year.
As many of you know, our annual cash incentive is based on EPS targets. And for this year, we adopted a deposit growth component into our incentive plan, and that deposit component is driving the incentive accrual for our associates.
With the additional provisioning this year, our EPS incentive target is likely to be DOA, absent some remarkable end between now and year-end. We're working with our Board to provide some additional opportunity for our associates so that we can keep them highly energized and motivated to ramp up the operating performance of the firm going into 2021. We're targeting an incremental 25% of target incentive.
So in total, call it, 50% of their annual incentive target inclusive of the deposit component. We spent a lot of time on CECL last quarter, so we will be brief this time. We anticipated last time that we would have another reserve build this quarter.
As Terry mentioned, our reserve without PPP loans is at 1.41%, up from 1.09% last quarter.
We also increased our off-balance sheet reserve. And as you probably know, that $4.5 million is in our noninterest expense line. We included some additional information regarding unemployment and GDP forecasts. These are the two metrics that influence our CECL model building the most. Unemployment being the most impactful, you can see the weighted average unemployment rates in the green chart comparing last quarter to this quarter compared to our rates that we've used to at least one large-cap firm that published figures recently.
Our 2Q 2020 weighted average rates are slightly lower than theirs, but our 1Q 2020 weighted average rates are definitely higher.
So apples-to-apples, last quarter, we would have allocated more reserves as a result of unemployment rates in this quarter slightly less. Over and above all that, we added another $20 million in the reserve through a qualitative overlay just due to the uncertainty around the depth and duration of the pandemic that exists.
As for 3Q, I think we're all in a weird spot. Every bank is working in their own portfolio in an effort to gain more visibility as to loss content. There's just a lot we don't know and it's difficult to predict. Two uncertainties are that the U.S. Treasury will likely provide some amount of additional governmental assistance and loan deferrals will gradually work themselves through. Both of those, we believe, are positive. The big negative is, of course, the depth and duration of the pandemic. At Pinnacle, we've learned a lot about our borrowers over the last quarter and feel better about our book today, but we obviously will know more at September 30 with all steps that Tim's group is leading us through.
Our best guess right now is that we will continue to build reserves in the second half of the year until visibility improves.
Lastly, this slide addresses what we think going into the third quarter. No guarantees, but we're more optimistic about things in general than we were at the beginning of March. That said, loan growth is likely to be soft, deposit growth is as strong as we've ever experienced. It's an awful rate environment, we are optimistic that we can increase core bank loan spreads and lower deposit cost. PPP will have a significant influence on our results for the next few quarters.
As to fee, we have great confidence in BHG and – which I will discuss in a minute. Not anticipating mortgage to set another record, but they should have a solid third quarter. Expenses should be relatively stable, still not willing to offer full year guidance due to COVID and its impact on credit. All things considered, we feel confident PPNR will increase in the second half of the year.
Now briefly about tangible equity.
Our ratio dropped this quarter with the additional liquidity build and the PPP. These are high-quality assets that will eventually exit our balance sheet. We believe we will manage back into the high 8s and low 9s by year-end and into the first quarter of next year.
As to BHG, we've shown this slide before and it's intended to give you a snapshot of BHG's business flows over time and more importantly, how they're holding up during the pandemic. The green bars on the chart are originations and have ramped up with more loans being funded.
So business flows remain strong.
Second quarter volumes were down slightly from last quarter, but this is following a record first quarter. The blue bars are the loan on which gain on sale has been recorded as these loans are sold to downstream banks. This is the traditional BHG model with gain on sale revenues being generated. The blue bars did hit a record placement in the second quarter as the auction platform remains in great shape, and bankers remain excited to purchase BHG paper. The gold bars represent loans held by BHG on its balance sheet for which BHG will collect interest income. They are warehousing more loans on their balance sheet than they ever have and with the first securitization about to occur, the gold bar should back up some next quarter.
So from 30,000 feet business loans – business flows remain incredibly healthy. Loan originations remain strong, loan sales are at record levels. And BHG is prepared to execute on its first securitization within the next few weeks. The top left chart, we've shown on several occasions, the quality of BHG's borrowers has improved steadily in the first – in the last few years, but particularly in 2020. They continue to refine their scorecards and increase the quality of the borrowing base. Again, the right chart, and I reiterate, maybe the most powerful chart I have to offer related to BHG's steadily improving credit quality.
Looking at losses by vintage, losses continue to level out in earlier months since origination, thus pointing towards a lower loss percentage over the life of the underlying loans. Pandemic-related events will likely cause these lines to point upward, but the quality of the borrowing base, in our opinion, is very impressive and is much higher than the bars from just a few years ago, and I believe has helped investors better evaluate the opportunities with respect to participating in their upcoming securitizations. Concerning deferrals.
As of June 30, total deferrals represented about 15% of the total book, up from 13% this time last quarter, dentists continued to lead the group as expected, with a 35% deferral rate. BHG communicates with these borrowers frequently and look to see these numbers decrease meaningfully in the third quarter as deferral request are essentially nonexistent currently. We've updated historical charge-off and reserve bills. These are for loans that BHG has sold their network of community banks. The green bar shows that currently, they've got almost $3.2 billion in credit with banks who acquired their loans. The orange line shows the annual loss rate, while the blue line on the chart details the recourse accrual as a percentage of outstanding loans with these other banks.
For the first three months of 2020, losses were running at about 4.5% and picked up only slightly to 4.56% for the six months ended June 30. They have increased their recourse accrual again from 6.4% last quarter to 7.25% this quarter. We anticipate some additional building on this reserve going into the second half of 2020.
Lastly, we believe it's been a big year for BHG, and we anticipate big things for the rest of this year.
During the quarter, the credit markets improved, allowed BHG the opportunity to execute on their first securitization. We – Pinnacle was successful in accessing the credit markets with a $225 million preferred issuance in June. We and BHG believe that their securitization will be successful and we'll get them in a good spot to potentially execute on another securitization in the next six months or so. This allows BHG to continue to diversify its revenue stream away from gain on sales in the interest income and provide another very competitively priced funding source. More to come on this in the third quarter.
Lastly, as indicated on the slide, also now, BHG was named the Best Place to Work in the state of New York. They were number two last year, so it feels good to be number one. Congratulations to BHG on hitting that mark.
So here was a sleepy little upstate New York company that three friends started 20 years ago, they turned it into a 600-plus associate driven firm that is now the Best Place to Work in the state of New York. I suppose many have tried to replicate what they have built, but there's a special sauce at BHG.
We are BHG's biggest fans and are excited about the future of our partnership. And with that, I'll turn it over to Tim to talk about credit.